Question 1

Classification of a nonrecognition transaction as a continuation of an investment requires a qualified replacement asset.

Accepted Answer

According to IRC Section 1031, a nonrecognition transaction can be classified as a continuation of an investment only if the taxpayer acquires a qualified replacement asset as part of the transaction.

Question 2

The holding period of an asset received in a like-kind exchange includes the holding period of the transferred asset.

Accepted Answer

The holding period of the asset received in a like-kind exchange includes the holding period of the transferred asset, as per the Internal Revenue Service (IRS) regulations. This helps in determining the applicable capital gains tax rates on the newly acquired asset.

Question 3

For related parties to qualify for a like-kind exchange, the property received must be held for six months.

Accepted Answer

The related parties involved in a like-kind exchange must hold the property received for two years to qualify for a like-kind exchange, not six months.

Question 4

The recognition of a loss realized on an involuntary conversion is mandatory.

Accepted Answer

When an involuntary conversion occurs, such as when property is destroyed or condemned, the taxpayer must recognize any resulting loss. This loss recognition is mandatory and cannot be avoided.

Question 5

In general, qualified replacement property for an involuntary conversion must be purchased within one year after the close of the tax year in which the involuntary conversion occurred.

Accepted Answer

Qualified replacement property for an involuntary conversion generally must be purchased within a period that begins one year before and ends two years after the close of the first tax year in which any part of the gain from the conversion is realized. However, for properties compulsorily or involuntarily converted as a result of certain presidentially declared disasters, the period is extended to four years.

Question 6

Gain deferral is fundamental to the nonrecognition transactions. In which of the following is gain deferral mandatory? I. Involuntary conversion of business real estate. II. Like-kind exchange of business real estate.
A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements are correct.
D) Neither statement is correct.

Accepted Answer

Gain deferral is mandatory in like-kind exchanges of business real estate. While gain deferral is also common in involuntary conversions of business real estate, it is not mandatory and the property owner may elect to recognize the gain.

Question 7

When two qualified assets are exchanged and their fair market values are not equal, additional nonqualifying property referred to as "boot" can be used to equalize the transaction without disqualifying the nonrecognition transaction.

Accepted Answer

This statement is true. The additional property, also known as boot, can be added to the transaction to balance out the value of the assets being exchanged without disqualifying the nonrecognition transaction.

Question 8

An involuntary conversion occurs whenever a loss but not a gain) is realized from a transaction that occurs against the taxpayer's will.

Accepted Answer

An involuntary conversion can occur with both a loss and a gain; it refers to the process where property is destroyed, stolen, condemned, or disposed of under the threat of condemnation and the proceeds are reinvested in similar property, not just to situations resulting in a loss.

Question 9

The basis of replacement property in a nonrecognition transaction is the adjusted basis of the property received less any deferred gain.

Accepted Answer

The basis of replacement property in a nonrecognition transaction is generally the adjusted basis of the property given up, increased by any gain recognized on the transaction or decreased by any money received and any loss recognized.

Question 10

Ed and Elise got married during the year and they each sold their homes to buy a new house for them to live in. As long as they file a joint return they can each claim a $250,000 exclusion.

Accepted Answer

This is true according to the IRS rules for home sale exclusion. As long as Ed and Elise file a joint return and meet other qualifications, they can each claim a maximum exclusion of $250,000 for their share of the gain on the sale of their individual homes. This means they could exclude up to $500,000 of gain on the sale of their homes if they meet all the requirements.

Question 11

Which of the following can be income deferral transactions? I. Sale of municipal bonds. II. Involuntary conversions of property.
A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements are correct.
D) Neither statement is correct.

Accepted Answer

Only statement II is correct. Involuntary conversions of property can be considered as income deferral transactions. Municipal bonds are tax-exempt, so they are not considered an income deferral transaction.

Question 12

Nancy purchased her houseboat six years ago for $35,000. She has lived in the houseboat since she purchased it. A friend has offered $62,000 for the houseboat. If she sells it, she will be able to exclude the gain.

Accepted Answer

According to IRS rules, if a taxpayer sells a primary residence they have owned and lived in for at least 2 out of the past 5 years, they can exclude up to $250,000 of the gain from their taxable income (or up to $500,000 if they are married and file a joint tax return). Nancy has owned and lived in the houseboat for six years, so she meets this criteria and would be able to exclude the gain from her taxable income.

Question 13

Taxpayers are allowed to structure transactions through third parties that qualify as exchanges if they meet certain time requirements for identifying properties and closing the transaction.

Accepted Answer

This is true. Taxpayers can engage in tax-deferred exchanges through third-party intermediaries such as qualified intermediaries (QIs) or exchange accommodation titleholders (EATs) if they meet certain requirements such as identifying the properties within 45 days and closing the transaction within 180 days.

Question 14

A gain on a like-kind exchange is always recognized to the extent of any boot received.

Accepted Answer

A gain on a like-kind exchange may be deferred or recognized depending on the presence or absence of boot (non-like-kind property received). If no boot is received, and the exchange meets all other requirements of Section 1031, the gain can be deferred. However, if boot is received, the gain recognized is limited to the lesser of the realized gain or the boot received.

Question 15

The deferral of a gain realized on an involuntary conversion is mandatory.

Accepted Answer

The deferral of a gain realized on an involuntary conversion (such as property destroyed by a natural disaster and then replaced) is not mandatory; taxpayers can choose to report the gain or to defer recognition of the gain by reinvesting the proceeds into similar property within a specified period.

Question 16

A fire destroyed Josh's Scuba Shop. The business had an adjusted basis of $500,000 and a fair market value of $600,000. Josh received $550,000 from the insurance company and used the cash to go to Hawaii. I. Josh has a realized gain of $100,000. II. Josh has a recognized gain of $50,000.
A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements are correct.
D) Neither statement is correct.

Accepted Answer

The answer of A fire destroyed Josh's Scuba Shop. The...

Question 17

Which of the following can be income deferral transactions? I. Exchanges of like-kind property. II. Involuntary conversions of property.
A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements are correct.
D) Neither statement is correct.

Accepted Answer

Both exchanges of like-kind property and involuntary conversions of property can be income deferral transactions. An exchange of like-kind property is when a taxpayer exchanges one property for another property of the same nature or character. This allows the taxpayer to defer any gain on the exchange until a later date. Involuntary conversion of property occurs when the taxpayer's property is destroyed or taken by government action, and the taxpayer receives insurance proceeds or other compensation. This type of transaction may also allow the taxpayer to defer any gain until a later date.

Question 18

The mechanism for effecting a deferral in a nonrecognition transaction is an adjustment of the replacement asset's basis.

Accepted Answer

When a nonrecognition transaction is involved, such as a like-kind exchange or involuntary conversion, the gain or loss is deferred and the basis of the replacement asset is adjusted to reflect the deferred gain or loss.

Question 19

Simon exchanged his Mustang for Michael's Econovan so that he could go hunting. The exchange does not qualify as a like-kind exchange since the assets are personal.

Accepted Answer

Like-kind exchanges only apply to real property and certain types of personal property used for business or investment purposes, not personal assets like a Mustang or Econovan used for personal activities like hunting.

Question 20

A fire destroyed Jimmy's Teeshirt Shop. The business had an adjusted basis of $500,000 and a fair market value of $600,000 before the fire. Jimmy received $550,000 from the insurance company and opened a new Teeshirt Shop with the proceeds. I. Jimmy has a realized gain of $50,000. II. Jimmy has a recognized gain of $50,000.
A) Only statement I is correct.
B) Only statement II is correct.
C) Both statements are correct.
D) Neither statement is correct.

Accepted Answer

Jimmy has a realized gain of $50,000 because the insurance proceeds of $550,000 exceed the adjusted basis of $500,000. However, if he reinvests the insurance proceeds in a similar property (a new Teeshirt Shop), he may not have to recognize this gain for tax purposes, depending on specific tax regulations.

Quiz 12: Non-Recognition Transactions